UNIVERSAL HEALTH REALTY INCOME TRUST Overview
We are a real estate investment trust ("REIT") that commenced operations in
1986. We invest in healthcare and human service related facilities currently
including acute care hospitals, behavioral health care hospitals, specialty
facilities, free-standing emergency departments, childcare centers and
medical/office buildings. As of
• six hospital facilities consisting of three acute care hospitals and three
behavioral health care hospitals;
• four free-standing emergency departments ("FEDs");
• fifty-nine medical/office buildings, including four owned byunconsolidated limited liability companies ("LLCs")/limited liability
partnerships ("LPs");
• four preschool and childcare centers, and;
• three specialty facilities that are currently vacant.
Forward Looking Statements and Certain Risk Factors
You should carefully review all of the information contained in this Quarterly Report, and should particularly consider any risk factors that we set forth in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , this Quarterly Report and in other reports or documents that we file from time to time with theSecurities and Exchange Commission (the "SEC"). In this Quarterly Report, we state our beliefs of future events and of our future financial performance. This Quarterly Report contains "forward-looking statements" that reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Words such as "may," "will," "should," "could," "would," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," "appears," "projects" and similar expressions, as well as statements in future tense, identify forward-looking statements. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks described elsewhere herein and in our Annual Report on Form 10-K for the year endedDecember 31, 2021 in Item 1A Risk Factors and in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Forward Looking Statements and in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations-Forward Looking Statements and Risk Factors, as included herein. Those factors may cause our actual results to differ materially from any of our forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or our good faith belief with respect to future events and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Such factors include, among other things, the following:
• Future operations and financial results of our tenants, and in turn ours,
will likely be materially impacted by numerous factors and future
developments related to COVID-19. Such factors and developments include, but
are not limited to, the length of time and severity of the spread of the
pandemic; the volume of cancelled or rescheduled elective procedures and the
volume of COVID-19 patients treated by the operators of our hospitals and
other healthcare facilities; measures our tenants are taking to respond to
the COVID-19 pandemic; the impact of government and administrative
regulation, including travel bans and restrictions, shelter-in-place or
stay-at-home orders, quarantines, the promotion of social distancing,
business shutdowns and limitations on business activity; vaccinerequirements; changes in patient volumes at our tenants' hospitals and other
healthcare facilities due to patients' general concerns related to the risk
of contracting COVID-19 from interacting with the healthcare system; changes
in patient volumes and payer mix caused by deteriorating macroeconomic
conditions (including increases in uninsured and underinsured patients as
the result of business closings and layoffs); potential disruptions to
clinical staffing and shortages and disruptions related to supplies required
for our tenants' employees and patients, including equipment,
pharmaceuticals and medical supplies, potential increases to expenses
incurred by our tenants related to staffing, supply chain or other
expenditures; the impact of our indebtedness and the ability to refinance
such indebtedness on acceptable terms; disruptions in the financial markets
and the business of financial institutions as the result of the COVID-19
pandemic which could impact our ability to access capital or increase
associated borrowing costs; and changes in general economic conditions
nationally and regionally in the markets our properties are located
resulting from the COVID-19 pandemic, including higher sustained rates of
unemployment and underemployment levels and reduced consumer spending and
confidence. The nationwide shortage of nurses and other clinical staff and
support personnel has been a significant operating issues facing our
healthcare provider tenants, including UHS. In some areas, the labor
scarcity is putting a strain on the resources of our tenants and their
staff, which has required them to utilize higher-cost temporary labor and
pay premiums
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above standard compensation for essential workers. In addition to
significantly increasing the labor cost of our tenants, the healthcare
staffing shortage could also require the operators of our hospital
facilities to limit the services provided which would have an adverse effect
on their operating revenues. There may be significant declines in future
bonus rental revenue earned on one acute care hospital leased to a
subsidiary of UHS to the extent that the hospital experiences significant
declines in patient volumes and revenues. These factors may result in the
inability or unwillingness on the part of some of our tenants to make timely
payment of their rent to us at current levels or to seek to amend or
terminate their leases which, in turn, would have an adverse effect on our
occupancy levels and our revenue and cash flow and the value of our
properties, and potentially, our ability to maintain our dividend at current
levels.
• Due to COVID-19 restrictions and its impact on the economy, we mayexperience a decrease in prospective tenants which could unfavorably impact
the volume of new leases, as well as the renewal rate of existing leases.
The COVID-19 pandemic may delay our construction projects which could result
in increased costs and delay the timing of opening and rental payments from
those projects, although no such delays have yet occurred. The COVID-19
pandemic could also impact our indebtedness and the ability to refinance
such indebtedness on acceptable terms, as well as risks associated with
disruptions in the financial markets and the business of financial
institutions as the result of the COVID-19 pandemic which could impact us
from a financing perspective; and changes in general economic conditions
nationally and regionally in the markets our properties are located
resulting from the COVID-19 pandemic. Although COVID-19 has not previously
had a material adverse impact on our financial results, we are not able to
quantify the impact that these factors could have on our future financial
results and therefore can provide no assurance that developments related to
the COVID-19 pandemic will not have a material adverse impact on our future
financial results.
• The
Final Rule ("IFR") effective
vaccinations for all applicable staff at all Medicare and Medicaid certified
facilities. Under the IFR, facilities covered by this regulation must
establish a policy ensuring all eligible staff have received the COVID-19
vaccine prior to providing any care, treatment, or other services by
to be fully vaccinated. The regulation also provides for exemptions based on
recognized medical conditions or religious beliefs, observances, or
practices. Under the IFR, facilities must develop a similar process or plan
for permitting exemptions in alignment with federal law. If facilities fail
to comply with the IFR by the deadlines established, they are subject to
potential termination from the Medicare and Medicaid program for
non-compliance. We cannot predict at this time the potential viability or
impact of any additional vaccine requirements on us or the operators of our
facilities. Implementation of these rules could have an impact on staffing
at the operators of our facilities for those employees that are not
vaccinated in accordance with IFR requirements, and associated loss of
revenues and increased costs resulting from staffing issues could have a
material adverse effect on our financial results or those of the operators.
• Recent legislation, including the Coronavirus Aid, Relief, and Economic
Security Act (the "CARES Act"), the Paycheck Protection Program and Health
Care Enhancement Act ("PPPHCE Act") and the American Rescue Plan Act of 2021
("ARPA"), has provided grant funding to hospitals and other healthcare
providers to assist them during the COVID-19 pandemic. There is a high
degree of uncertainty surrounding the implementation of the CARES Act, the
PPPHCE Act and ARPA, and the federal government may consider additional
stimulus and relief efforts, but we are unable to predict whether additional
stimulus measures will be enacted or their impact. There can be no assurance
as to the total amount of financial and other types of assistance our
tenants will receive under the CARES Act, the PPPHCE Act and the ARPA, and
it is difficult to predict the impact of such legislation on our tenants'
operations or how they will affect operations of our tenants'
competitors. There can be no assurance as to whether our tenants would be
required to repay any previously granted funding, due to noncompliance with
grant terms or otherwise. Moreover, we are unable to assess the extent to
which anticipated negative impacts on our tenants (and, in turn, us) arising
from the COVID-19 pandemic will be offset by amounts or benefits received or
to be received under the CARES Act, the PPPHCE Act and the ARPA.
• A substantial portion of our revenues are dependent upon one operator, UHS,
which comprised approximately 41% and 37% of our consolidated revenues for
the three-month periods ended
approximately 41% and 36% of our consolidated revenues for the nine-month
periods ended
disclosed, on
the real estate assets of Inland Valley Campus of
System from us and in exchange, transferred the real estate assets of Aiken
transactions were approved by the Independent Trustees of our Board, as well
as the UHS Board of Directors. The aggregate annual rental revenue during
2022 pursuant to the leases for the two facilities transferred to us is
approximately
either of these leases. Pursuant to the terms of the lease on the Inland
Valley Campus, we earned
rental).
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--------------------------------------------------------------------------------• We cannot assure you that subsidiaries of UHS will renew the leases on the
hospital facilities and free-standing emergency departments, upon the
scheduled expirations of the existing lease terms. In addition, if
subsidiaries of UHS exercise their options to purchase the respective leased
hospital facilities and FEDs, and do not enter into a substitution
arrangement upon expiration of the lease terms or otherwise, our future
revenues and results of operations could decrease if we were unable to earn
a favorable rate of return on the sale proceeds received, as compared to the
rental revenue currently earned pursuant to these leases.
• In certain of our markets, the general real estate market has beenunfavorably impacted by increased competition/capacity and decreases in
occupancy and rental rates which may adversely impact our operating results
and the underlying value of our properties.
• A number of legislative initiatives have recently been passed into law that
may result in major changes in the health care delivery system on a national
or state level to the operators of our facilities, including UHS. No
assurances can be given that the implementation of these new laws will not
have a material adverse effect on the business, financial condition or
results of operations of our operators.
• The potential indirect impact of the Tax Cuts and Jobs Act of 2017, signed
into law on
and individual tax rates and calculation of taxes, which could potentially
impact our tenants and jurisdictions, both positively and negatively, in
which we do business, as well as the overall investment thesis for REITs.
• A subsidiary of UHS is our Advisor and our officers are all employees of a
wholly-owned subsidiary of UHS, which may create the potential for conflicts
of interest.
• Lost revenues resulting from the exercise of purchase options, lease
expirations and renewals and other transactions (see Note 7 to the condensed
consolidated financial statements - Lease Accounting for additional
disclosure related to lease expirations and subsequent vacancies that
occurred during the second and third quarters of 2019 and the fourth quarter
of 2021 on three specialty hospital facilities).
• Potential unfavorable tax consequences and reduced income resulting from an
inability to complete, within the statutory timeframes, anticipated tax
deferred like-kind exchange transactions pursuant to Section 1031 of the
Internal Revenue Code, if, and as, applicable from time-to-time.
• Our ability to continue to obtain capital on acceptable terms, including
borrowed funds, to fund future growth of our business.
• The outcome and effects of known and unknown litigation, governmentinvestigations, and liabilities and other claims asserted against us, UHS or
the other operators of our facilities. UHS and its subsidiaries are subject
to legal actions, purported shareholder class actions and shareholder
derivative cases, governmental investigations and regulatory actions and the
effects of adverse publicity relating to such matters. Since UHS comprised
approximately 41% of our consolidated revenues during each of the three and
nine-month periods ended
subsidiary of UHS is our Advisor, you are encouraged to obtain and review
the disclosures contained in the Legal Proceedings section of Universal
Health Services, Inc.'s Forms 10-Q and 10-K, as publicly filed with theSecurities and Exchange Commission . Those filings are the sole responsibility of UHS and are not incorporated by reference herein.
• Failure of UHS or the other operators of our hospital facilities to comply
with governmental regulations related to the Medicare and Medicaid licensing
and certification requirements could have a material adverse impact on our
future revenues and the underlying value of the property.
• The potential unfavorable impact on our business of the deterioration in
national, regional and local economic and business conditions, including a
worsening of credit and/or capital market conditions, which may adversely
affect our ability to obtain capital which may be required to fund the
future growth of our business and refinance existing debt with near term
maturities.
• A continuation in the deterioration in general economic conditions which has
resulted in increases in the number of people unemployed and/or insured and
likely increase the number of individuals without health insurance. Under
these circumstances, the operators of our facilities may experience declines
in patient volumes which could result in decreased occupancy rates at our
medical office buildings.
• A continuation of the worsening of the economic and employment conditions in
operators, including UHS, which would likely unfavorably impact our future
bonus rental revenue (on one UHS hospital facility) and may potentially have
a negative impact on the future lease renewal terms and the underlying value
of the hospital properties.
• In 2021, the rate of inflation in
has since risen to levels not experienced in over 40 years. Our tenants are
experiencing inflationary pressures, primarily in personnel costs, and we
anticipate impacts on other
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--------------------------------------------------------------------------------cost areas within the next twelve months. The extent of any future impacts
from inflation on our tenants' businesses and results of operations will be
dependent upon how long the elevated inflation levels persist and the extent
to which the rate of inflation further increases, if at all, neither of
which we are able to predict. If elevated levels of inflation were to
persist or if the rate of inflation were to accelerate, expenses of our
tenants, and our direct operating expenses that are not passed on to ourtenants, could increase faster than anticipated and may require utilization
of our and our tenants' capital resources sooner than expected. Further,
given the complexities of the reimbursement landscape in which our tenants
operate, their payors may be unwilling or unable to increase reimbursement
rates to compensate for inflationary impacts. This may impact their ability
and willingness to make rental payments. In addition, increased interest
rates on our borrowings and increased construction costs could affect our
ability to make additional attractive investments. As such, the effects of
inflation may unfavorably impact our future expenses and rental revenue and
may potentially have a negative impact on the future lease renewal terms,
the underlying value of our properties, our ability to grow our portfolio
and the value of our common shares.
• Real estate market factors, including without limitation, the supply and
demand of office space and market rental rates, changes in interest rates as
well as an increase in the development of medical office condominiums in
certain markets.
• The impact of property values and results of operations of severe weather
conditions, including the effects of hurricanes.
• Government regulations, including changes in the reimbursement levels under
the Medicare and Medicaid programs.
• The issues facing the health care industry that affect the operators of our
facilities, including UHS, such as: changes in, or the ability to comply
with, existing laws and government regulations; unfavorable changes in the
levels and terms of reimbursement by third party payors or government
programs, including Medicare (including, but not limited to, the potential
unfavorable impact of future reductions to Medicare reimbursements resulting
from the Budget Control Act of 2011, as discussed in the next bullet point
below) and Medicaid (most states have reported significant budget deficits
that have, in the past, resulted in the reduction of Medicaid funding to the
operators of our facilities, including UHS); demographic changes; the
ability to enter into managed care provider agreements on acceptable terms;
an increase in uninsured and self-pay patients which unfavorably impacts the
collectability of patient accounts; decreasing in-patient admission trends;
technological and pharmaceutical improvements that may increase the cost of
providing, or reduce the demand for, health care, and; the ability to
attract and retain qualified medical personnel, including physicians.
• The Budget Control Act of 2011 imposed annual spending limits for most
federal agencies and programs aimed at reducing budget deficits by $917
billion between 2012 and 2021, according to a report released by the
a bipartisan Congressional committee, known as the
Deficit Reduction (
recommendations aimed at reducing future federal budget deficits by an
additional
reach an agreement by the
across-the-board cuts to discretionary, national defense and Medicare
spending were implemented on
reductions of up to 2% per fiscal year with a uniform percentage reduction
across all Medicare programs. The Bipartisan Budget Act of 2015, enacted on
imposed under the Budget Control Act of 2011. Recent legislation has
suspended payment reductions through
extended cuts through 2030. Subsequent legislation extended the payment
reduction suspension through
from then until
thereafter. We cannot predict whether
implemented Medicare payment reductions or what other federal budget deficit
reduction initiatives may be proposed by
cannot predict the effect these enactments will have on the operators of our
properties (including UHS), and thus, our business.
• An increasing number of legislative initiatives have been passed into law
that may result in major changes in the health care delivery system on a
national or state level. Legislation has already been enacted that has
eliminated the penalty for failing to maintain health coverage that was part
of the original Patient Protection and Affordable Care Act (the "ACA").
actions that will strengthen the ACA and may reverse the policies of the
prior administration. To date, the Biden administration has issued executive
orders implementing a special enrollment period permitting individuals to
enroll in health plans outside of the annual open enrollment period and
reexamining policies that may undermine the ACA or the Medicaid program. The
ARPA's expansion of subsidies to purchase coverage through an exchange,
which the Inflation Reduction Act of 2022, passed on
continues through 2025, is anticipated to increase exchange enrollment. The
the formation of association health plans that would be exempt from certain
ACA requirements such as the provision of essential health benefits; (ii)
expanding the availability of short-term, limited duration health insurance,
(iii) eliminating cost-sharing reduction payments to insurers that would
otherwise offset deductibles and other out-of-pocket expenses for health
plan enrollees at or below 250 percent of the federal poverty level; (iv)
relaxing requirements for state innovation waivers that could reduce
enrollment in the individual and small group markets and lead to additional
enrollment in short-term, limited duration insurance and association health
plans; and (v) incentivizing the use of health reimbursement arrangements by
employers to permit employees to purchase health insurance in the individual
market. The uncertainty
24--------------------------------------------------------------------------------
resulting from these Executive Branch policies had led to reduced Exchange
enrollment in 2018, 2019 and 2020, and is expected to further worsen the
individual and small group market risk pools in future years. It is also
anticipated that these policies, to the extent that they remain as
implemented, may create additional cost and reimbursement pressures on
hospitals, including ours. In addition, while attempts to repeal theentirety of the ACA have not been successful to date, a key provision of the
ACA was eliminated as part of the Tax Cuts and Jobs Act and on
2018, a federal
unconstitutional. That ruling was ultimately appealed to
the matter lacked standing to bring their constitutionality claims. On
Becerra, ruled that certain Legislation provisions violate the Appointments
Clause of the
Act. Any future efforts to challenge, replace or replace the Legislation or
expand or substantially amend its provision is unknown.
• There can be no assurance that if any of the announced or proposed changes
described above are implemented there will not be negative financial impact
on the operators of our hospitals, which material effects may include a
potential decrease in the market for health care services or a decrease in
the ability of the operators of our hospitals to receive reimbursement for
health care services provided which could result in a material adverse
effect on the financial condition or results of operations of the operators
of our properties, and, thus, our business.
• Competition for properties includes, but is not limited to, other REITs,
private investors and firms, banks and other companies, including UHS. In
addition, we may face competition from other REITs for our tenants.
• The operators of our facilities face competition from other health care
providers, including physician owned facilities and other competing
facilities, including certain facilities operated by UHS but the real
property of which is not owned by us. Such competition is experienced in
markets including, but not limited to, McAllen, Texas , the site of our
McAllen Medical Center , a 370-bed acute care hospital.
• Changes in, or inadvertent violations of, tax laws and regulations and other
factors that can affect REITs and our status as a REIT, including possible
future changes to federal tax laws that could materially impact our ability
to defer gains on divestitures through like-kind property exchanges.• The individual and collective impact of the changes made by the CARES Act on
REITs and their security holders are uncertain and may not become evident
for some period of time; it is also possible additional legislation could be
enacted in the future as a result of the COVID-19 pandemic which may affect
the holders of our securities.
• Should we be unable to comply with the strict income distributionrequirements applicable to REITs, utilizing only cash generated by operating
activities, we would be required to generate cash from other sources which
could adversely affect our financial condition.
• Our ownership interest in four LLCs/LPs in which we hold non-controlling
equity interests. In addition, pursuant to the operating and/or partnership
agreements of the four LLCs/LPs in which we continue to hold non-controlling
ownership interests, the third-party member and the Trust, at any time,
potentially subject to certain conditions, have the right to make an offer
("Offering Member") to the other member(s) ("Non-Offering Member") in which
it either agrees to: (i) sell the entire ownership interest of the Offering
Member to the Non-Offering Member ("Offer to Sell") at a price as determined
by the Offering Member ("Transfer Price"), or; (ii) purchase the entire
ownership interest of the Non-Offering Member ("Offer to Purchase") at the
equivalent proportionate Transfer Price. The Non-Offering Member has 60 to
90 days to either: (i) purchase the entire ownership interest of the
Offering Member at the Transfer Price, or; (ii) sell its entire ownership
interest to the Offering Member at the equivalent proportionate Transfer
Price. The closing of the transfer must occur within 60 to 90 days of the
acceptance by the Non-Offering Member. Please see Note 5 to the condensed
consolidated financial statements - Summarized Financial Information of
Equity Affiliates for additional disclosure related to a fourth quarter,
2021 transaction between us and the minority partner in
LP.
• Fluctuations in the value of our common stock.
• Other factors referenced herein or in our other filings with the Securities
and
Given these uncertainties, risks and assumptions, you are cautioned not to place
undue reliance on such forward-looking statements. Our actual results and
financial condition, including the operating results of our lessees and the
facilities leased to subsidiaries of UHS, could differ materially from those
expressed in, or implied by, the forward-looking statements.
Forward-looking statements speak only as of the date the statements are made. We
assume no obligation to publicly update any forward-looking statements to
reflect actual results, changes in assumptions or changes in other factors
affecting forward-looking information, except as may be required by law. All
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by this cautionary statement.
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--------------------------------------------------------------------------------Critical Accounting Policies and Estimates
There have been no significant changes to our critical accounting policies or estimates from those disclosed in our 2021 Annual Report on Form 10-K.
Results of Operations
During the three-month period ended
• a decrease of
financial statements, the lease expired on
• a decrease of $569,000 resulting from an increase in interest expense
primarily due to an increase in our borrowing rate and increased
borrowings;
• a net increase of
agreement with UHS that occurred on
Note 2 to the consolidated financial statements;
• an increase of $193,000 resulting from the impact of the fair market
value lease renewal on Wellington Regional Medical Center , which became
effective on
financial statements, and;
• $222,000 of other combined net increases.
During the nine-month period ended
• a decrease of
second quarter of 2021 related to the sale of certain real estate
assets;
• a decrease of
located in
2021;
• a decrease of
primarily due to an increase in our borrowing rate and an increase in
our borrowings;
• a net increase of
agreement with UHS that occurred on December 31, 2021 ;
• an increase of $863,000 resulting from the impact of the fair market
value lease renewal on Wellington Regional Medical Center , which became
effective on January 1, 2022 , and;
• $500,000 of other combined net increases.
Revenues increased $946,000 to $22.2 million during the three-month period ended
September 30, 2022 , as compared to $21.2 million during the three-month period
ended September 30, 2021 . The increase during the third quarter of 2022, as
compared to the third quarter of 2021, was due to: (i) a $932,000 increase due
to the recording on a consolidated basis of Grayson Properties, LP (effective as
of November 1, 2021 as discussed in Note 5 to the consolidated financial
statements), resulting from our purchase of the 5% minority ownership interest
in the entity; (ii) a $193,000 increase resulting from the fair market value
lease renewal on Wellington Regional Medical Center , which became effective on
January 1, 2022 ; (iii) a $217,000 net increase resulting from the December 31,
2021 asset purchase and sale agreement with UHS whereby we divested the real
estate assets of the Inland Valley Campus of Southwest Healthcare System and
acquired the real estate assets of Aiken Regional Medical Center and Canyon
Creek Behavioral Health , partially offset by; (iv) a $6,000 aggregate net
decrease generated at various properties, including the impact of acquisitions
and divestitures, and; (v) a $390,000 decrease resulting from the December 31,
2021 lease expiration on the specialty hospital located in Chicago, Illinois .
Although our revenues and expenses increased during the third quarter of 2022,
as compared to the third quarter of 2021, resulting from the recording of
Grayson Properties, LP on a consolidated basis effective as of November 1, 2021 ,
there was no significant impact on our net income resulting from the change from
the unconsolidated/equity method basis.
Revenues increased $3.7 million to $66.5 million during the nine-month period
ended September 30, 2022 , as compared to $62.8 million during the nine-month
period ended September 30, 2021 . The increase during the first nine months of
2022, as compared to the first nine months of 2021, was due to: (i) a $2.8
million increase due to the recording on a consolidated basis of Grayson
Properties, LP (effective as of November 1, 2021 as discussed above and in Note
5 to the consolidated financial statements); (ii) an $863,000 increase resulting
from the fair market value lease renewal on Wellington Regional Medical Center ,
which became effective
26
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on January 1, 2022 ; (iii) a $740,000 net increase resulting from the December
31, 2021 asset purchase and sale agreement with UHS whereby we divested the real
estate assets of the Inland Valley Campus of Southwest Healthcare System and
acquired the real estate assets of Aiken Regional Medical Center and Canyon
Creek Behavioral Health ; (iv) a $507,000 aggregate net increase generated at
various properties, including the impact of acquisitions and divestitures,
partially offset by; (v) a $1.2 million decrease resulting from the December 31,
2021 lease expiration on the specialty hospital located in Chicago, Illinois . As
mentioned above, although our revenues and expenses increased during the first
nine months of 2022, as compared to the first nine months of 2021, resulting
from the recording of Grayson Properties, LP on a consolidated basis, there was
no significant impact on our net income resulting from the change from the
unconsolidated/equity method basis.
A large portion of the expenses associated with our consolidated medical office
buildings is passed on directly to the tenants either directly as tenant
reimbursements of common area maintenance expenses or included in base rental
amounts. Tenant reimbursements for operating expenses are accrued as revenue in
the same period the related expenses are incurred and are included as lease
revenue in our condensed consolidated statements of income.
Included in our other operating expenses are expenses related to the
consolidated medical office buildings and three vacant specialty facilities
amounting to $6.1 million and $5.3 million for the three-month periods ended
September 30, 2022 and 2021, respectively. The $800,000 increase in our other
operating expenses related to these facilities during the third quarter of 2022,
as compared to the third quarter of 2021, was due primarily to: (i) $240,000 of
operating expenses incurred during the third quarter of 2022 at a vacant
specialty facility located in Chicago, Illinois , on which the lease expired on
December 31, 2021 (the operating expenses for this facility were the tenant's
responsibility through the lease expiration date); (ii) $456,000 (excluding
ground lease expense) of other operating expenses recorded during the third
quarter of 2022 in connection with Grayson Properties, LP , which as discussed
above, was recorded on a consolidated basis effective as of November 1, 2021 ,
and; (iii) $104,000 of other combined increased expenses.
Other operating expenses related to the consolidated medical office buildings
and three vacant specialty facilities were $18.1 million and $15.1 million for
the nine-month periods ended September 30, 2022 and 2021, respectively. The $3.0
million increase in our other operating expenses related to these facilities
during the first nine months of 2022, as compared to the first nine months of
2021, was due primarily to: (i) $1.1 million of operating expenses incurred
during the first nine months of 2022 at the above-mentioned vacant specialty
facility located in Chicago, Illinois , on which the lease expired on December
31, 2021 ; (ii) $1.3 million (excluding ground lease expense) of other operating
expenses recorded during the first nine months of 2022 in connection with
Grayson Properties, LP , which as discussed above, was recorded on a consolidated
basis effective as of November 1, 2021 , and; (iii) $677,000 of other combined
increased expenses.
Funds from operations ("FFO") is a widely recognized measure of performance for
Real Estate Investment Trusts ("REITs"). We believe that FFO and FFO per diluted
share, which are non-GAAP financial measures, are helpful to our investors as
measures of our operating performance. We compute FFO in accordance with
standards established by the National Association of Real Estate Investment
Trusts ("NAREIT"), which may not be comparable to FFO reported by other REITs
that do not compute FFO in accordance with the NAREIT definition, or that
interpret the NAREIT definition differently than we interpret the definition.
FFO adjusts for the effects of certain items, such as gains on transactions that
occurred during the periods presented. To the extent a REIT recognizes a gain or
loss with respect to the sale of incidental assets, the REIT has the option to
exclude or include such gains and losses in the calculation of FFO. We have
opted to exclude gains and losses from sales of incidental assets in our
calculation of FFO. FFO does not represent cash generated from operating
activities in accordance with GAAP and should not be considered to be an
alternative to net income determined in accordance with GAAP. In addition, FFO
should not be used as: (i) an indication of our financial performance determined
in accordance with GAAP; (ii) an alternative to cash flow from operating
activities determined in accordance with GAAP; (iii) a measure of our liquidity,
or; (iv) an indicator of funds available for our cash needs, including our
ability to make cash distributions to shareholders.
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Below is a reconciliation of our reported net income to FFO for the three and
nine-month periods ended
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Net income $ 4,848 $ 5,344 $ 15,471 $ 17,551
Depreciation and amortization expense
on consolidated
investments 6,658 6,813 20,046 20,551
Depreciation and amortization expense
on unconsolidated
affiliates 295 460 885 1,196
Gain on sale of real estate assets - - - (1,304 )
Funds From Operations $ 11,801 $ 12,617 $ 36,402 $ 37,994
Weighted average number of shares
outstanding - Diluted 13,801 13,783 13,792 13,777
Funds From Operations per diluted
share $ 0.86 $ 0.92 $
2.64
Our FFO decreased$816,000 during the third quarter of 2022, as compared to the third quarter of 2021. The net decrease was primarily due to: (i) a net decrease in net income of$496,000 , as discussed above, and; (ii) a$320,000 decrease in depreciation and amortization expense incurred on our consolidated and unconsolidated affiliates. Our FFO decreased$1.6 million during the first nine months of 2022, as compared to the first nine months of 2021. The net decrease was primarily due to: (i) the net decrease in net income of$776,000 ; excluding the$1.3 million gain recorded during the second quarter of 2021 related to the sale of certain real estate assets (which we exclude from our calculation of FFO), as discussed above, and; (ii) a$816,000 decrease in depreciation and amortization expense incurred on our consolidated and unconsolidated affiliates.
Other Operating Results
Interest Expense:
As reflected in the schedule below, interest expense was$2.8 million and$2.3 million during the three-month periods endedSeptember 30, 2022 and 2021, respectively, and$7.4 million and$6.6 million during the nine-month periods endedSeptember 30, 2022 and 2021, respectively (amounts in thousands): Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 30, September 30, September 30, September 30, 2022 2021 2022 2021 Revolving credit agreement $ 2,641 $ 1,131 $ 5,359 $ 3,127 Mortgage interest 543 623 1,739 1,887 Interest rate swaps (income)/expense, net (a.) (411 ) 328 (37 ) 957 Amortization of financing fees 177 176 538 608 Amortization of fair value of debt (13 ) (13 ) (39 ) (39 ) Capitalized interest on major projects (97 ) - (153 ) - Other interest (21 ) 5 1 26 Interest expense, net $ 2,819 $ 2,250 $ 7,408 $ 6,566
(a.) Represents interest paid (to us)/by us to the counterparties pursuant to
three interest rate SWAPs with a combined notional amount of
Interest expense increased by$569,000 during the three-month period endedSeptember 30, 2022 , as compared to the comparable period of 2021, due primarily to: (i) a$1.5 million increase in the interest expense on our revolving credit agreement primarily resulting from an increase in our average cost of borrowings (3.71% average effective rate during the third quarter of 2022, as compared to 1.73% average effective rate during the comparable quarter of 2021) as well as an increase in our average outstanding borrowings ($282.4 million during the three months endedSeptember 30, 2022 as compared to$259.8 million in the comparable quarter of 2021), partially offset by; (ii) a$739,000 favorable change in interest rate swap income/expense; (iii) an$80,000 decrease in mortgage interest expense; (iv) a$97,000 decrease due to an increase in capitalized interest on a major project, and; (v) a$25,000 decrease in other interest expense. Interest expense increased by$842,000 during the nine-month period endedSeptember 30, 2022 , as compared to the comparable period of 2021, due primarily to: (i) a$2.2 million increase in the interest expense on our revolving credit agreement primarily resulting from an increase in our average cost of borrowings (2.61% average effective rate during the first nine months of 2022, as compared to 1.68% average effective rate during the comparable nine months of 2021) as well as an increase in our average outstanding borrowings ($274.7 million during the nine months endedSeptember 30, 2022 as compared to$249.1 million in the comparable nine-month period of 2021), partially offset by; (ii) a$994,000 favorable change in interest rate swap income/expense; 28 -------------------------------------------------------------------------------- (iii) a$148,000 decrease in mortgage interest expense; (iv) a$70,000 decrease in amortization of financing fees and fair value of debt; (v) a$153,000 decrease due to an increase in capitalized interest on a major project, and; (vi) a$25,000 decrease in other interest expense.
Disclosures Related to Certain Facilities
Please refer to Note 7 to the consolidated financial statements - Lease Accounting, for additional information regarding certain of our vacant specialty hospital facilities consisting ofEvansville, Indiana ;Corpus Christi, Texas , and;Chicago, Illinois .
Liquidity and Capital Resources
Net cash provided by operating activities
Net cash provided by operating activities was$34.5 million during the nine-month period endedSeptember 30, 2022 as compared to$36.2 million during the comparable period of 2021. The$1.7 million net decrease was attributable to:
• an unfavorable change of
plus/minus the adjustments to reconcile net income to net cash provided
by operating activities (depreciation and amortization, amortization
related to above/below market leases, amortization of debt premium,
amortization of deferred financing costs, stock-based compensation and
gain on sale of real estate assets), as discussed above;
• an unfavorable change of $1.1 million in lease receivable;
• an unfavorable change of $689,000 in tenant reserves, deposits and
deferred and prepaid rents;
• an unfavorable change of $171,000 in leasing costs paid;
• a favorable change of $776,000 in accrued expenses and other
liabilities, and;
• other combined net favorable change of
from the timing of prepaid expense payments.
Net cash used in investing activities
Net cash used in investing activities was
During the nine-month period endedSeptember 30, 2022 we funded: (i)$13.6 million , including transaction costs, on the acquisitions of the Beaumont Heart and Vascular Center in March, 2022, and; the140 Thomas Johnson Drive medical office building in January, 2022, as discussed in Note 4 to the consolidated financial statements-Acquisitions and Divestitures; (ii)$16.7 million in additions to real estate investments including construction costs related to the Sierra MedicalPlaza I medical office building located inReno, Nevada , that is scheduled to be completed during the first quarter of 2023, as well as tenant improvements at various MOBs; (iii)$1.3 million as part of the asset purchase and sale agreement with UHS, as discussed in Note 2 to the consolidated financial statements-Relationship with UHS and Related Party Transactions, and; (iv)$94,000 in equity investments in unconsolidated LLCs. In addition, during the nine months endedSeptember 30, 2022 , we received approximately$516,000 of cash in excess of income from LLCs. During the nine-month period endedSeptember 30, 2021 we funded: (i)$13.0 million , including transaction costs, on the acquisition of the Fire Mesa office building in May, 2021, as discussed in Note 4 to the consolidated financial statements-Acquisitions and Dispositions; (ii)$11.5 million in additions to real estate investments including construction costs related to the 100-bed behavioral health care hospital located inClive, Iowa , that was substantially completed in late December, 2020, as well as tenant improvements at various MOBs; (iii) a$3.5 million member loan to an unconsolidated LP; (iv)$200,000 in a deposit on real estate assets, and; (v)$16.1 million in equity investments in unconsolidated LLCs, including$13.2 million to repay a mortgage. In addition, during the nine months endedSeptember 30, 2021 , we received approximately$3.2 million of net cash proceeds from the sale of theChildren's Clinic of Springdale as discussed in Note 4 to the consolidated financial statements-Acquisitions and Dispositions.
Net cash (used in)/provided by financing activities
Net cash used in financing activities was
During the nine-month period endedSeptember 30, 2022 , we paid: (i)$6.7 million on mortgage notes payable that are non-recourse to us, including a$5.1 million repayment of a fixed rate mortgage loan that matured during the second quarter of 2022; (ii)$26,000 of financing costs related to the revolving credit agreement, and; (iii)$29.3 million of dividends, including$60,000 of accrued dividends. 29 -------------------------------------------------------------------------------- Additionally, during the nine months endedSeptember 30, 2022 , we received: (i)$18.2 million of net borrowings on our revolving credit agreement, and; (ii)$136,000 of net cash from the issuance of shares of beneficial interest. During the nine-month period endedSeptember 30, 2021 , we paid: (i)$1.6 million on mortgage notes payable that are non-recourse to us; (ii)$1.8 million of financing costs, primarily related to theJuly 2, 2021 amended and restated revolving credit agreement, and; (iii)$28.8 million of dividends. Additionally, during the nine months endedSeptember 30, 2021 , we received: (i)$40.6 million of net borrowings on our revolving credit agreement, and; (ii)$159,000 of net cash from the issuance of shares of beneficial interest. During 2020, we commenced an at-the-market ("ATM") equity issuance program, pursuant to the terms of which we may sell, from time-to-time, common shares of our beneficial interest up to an aggregate sales price of$100 million to or through our agent banks. No shares were issued pursuant to this ATM equity program during the first nine months of 2022 and no shares were issued pursuant to this ATM equity program during the year endedDecember 31, 2021 .
Additional cash flow and dividends paid information for the nine-month periods
ended
As indicated on our condensed consolidated statement of cash flows, we generated net cash provided by operating activities of$34.5 million and$36.2 million during the nine-month periods endedSeptember 30, 2022 and 2021, respectively. As also indicated on our statement of cash flows, non-cash expenses including depreciation and amortization expense, amortization related to above/below market leases, amortization of debt premium, amortization of deferred financing costs, stock-based compensation expense and gain on sale of real estate assets are the primary differences between our net income and net cash provided by operating activities during each period. We declared and paid dividends of$29.3 million and$28.8 million during the nine-month periods endedSeptember 30, 2022 and 2021, respectively. During the first nine months of 2022, the$34.5 million of net cash provided by operating activities was approximately$5.2 million greater than the$29.3 million of dividends paid during the first nine months of 2022. During the first nine months of 2021, the$36.2 million of net cash provided by operating activities was approximately$7.4 million greater than the$28.8 million of dividends paid during the first nine months of 2021. As indicated in the cash flows from investing activities and cash flows from financing activities sections of the statements of cash flows, there were various other sources and uses of cash during the nine months endedSeptember 30, 2022 and 2021. From time to time, various other sources and uses of cash may include items such as investments and advances made to/from LLCs, additions to real estate investments, acquisitions/divestiture of properties, net borrowings/repayments of debt, and proceeds generated from the issuance of equity. Therefore, in any given period, the funding source for our dividend payments is not wholly dependent on the operating cash flow generated by our properties. Rather, our dividends as well as our capital reinvestments into our existing properties, acquisitions of real property and other investments are funded based upon the aggregate net cash inflows or outflows from all sources and uses of cash from the properties we own either in whole or through LLCs, as outlined above. In determining and monitoring our dividend level on a quarterly basis, our management andBoard of Trustees consider many factors in determining the amount of dividends to be paid each period. These considerations primarily include: (i) the minimum required amount of dividends to be paid in order to maintain our REIT status; (ii) the current and projected operating results of our properties, including those owned in LLCs, and; (iii) our future capital commitments and debt repayments, including those of our LLCs. Based upon the information discussed above, as well as consideration of projections and forecasts of our future operating cash flows, management and theBoard of Trustees have determined that our operating cash flows have been sufficient to fund our dividend payments. Future dividend levels will be determined based upon the factors outlined above with consideration given to our projected future results of operations. We expect to finance all capital expenditures and acquisitions and pay dividends utilizing internally generated and additional funds. Additional funds may be obtained through: (i) borrowings under our$375 million revolving credit agreement (which had$81.8 million of available borrowing capacity, net of outstanding borrowings and letters of credit as ofSeptember 30, 2022 ); (ii) borrowings under or refinancing of existing third-party debt pursuant to mortgage loan agreements entered into by our consolidated and unconsolidated LLCs/LPs; (iii) the issuance of equity pursuant to our ATM program, and/or; (iv) the issuance of other long-term debt. We believe that our operating cash flows, cash and cash equivalents, available borrowing capacity under our revolving credit agreement and access to the capital markets provide us with sufficient capital resources to fund our operating, investing and financing requirements for the next twelve months, including providing sufficient capital to allow us to make distributions necessary to enable us to continue to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986. In the event we need to access the capital markets or other sources of financing, there can be no assurance that we will be able to obtain financing on acceptable terms or within an acceptable time. Our inability to obtain financing on terms acceptable to us could have a material unfavorable impact on our results of operations, financial condition and liquidity. 30 --------------------------------------------------------------------------------
Credit facilities and mortgage debt
Management routinely monitors and analyzes the Trust's capital structure in an effort to maintain the targeted balance among capital resources including the level of borrowings pursuant to our revolving credit facility, the level of borrowings pursuant to non-recourse mortgage debt secured by the real property of our properties and our level of equity including consideration of additional equity issuances pursuant to our ATM equity issuance program. This ongoing analysis considers factors such as the current debt market and interest rate environment, the current/projected occupancy and financial performance of our properties, the current loan-to-value ratio of our properties, the Trust's current stock price, the capital resources required for anticipated acquisitions and the expected capital to be generated by anticipated divestitures. This analysis, together with consideration of the Trust's current balance of revolving credit agreement borrowings, non-recourse mortgage borrowings and equity, assists management in deciding which capital resource to utilize when events such as refinancing of specific debt components occur or additional funds are required to finance the Trust's growth. OnJuly 2, 2021 , we entered into an amended and restated revolving credit agreement ("Credit Agreement") to amend and restate the previously existing$350 million credit agreement, as amended and datedJune 5, 2020 ("Prior Credit Agreement"). Among other things, under the Credit Agreement, our aggregate revolving credit commitment was increased to$375 million from$350 million . The Credit Agreement, which is scheduled to mature onJuly 2, 2025 , provides for a revolving credit facility in an aggregate principal amount of$375 million , including a$40 million sublimit for letters of credit and a$30 million sublimit for swingline/short-term loans. Under the terms of the Credit Agreement, we may request that the revolving line of credit be increased by up to an additional$50 million . Borrowings under the new facility are guaranteed by certain subsidiaries of the Trust. In addition, borrowings under the new facility are secured by first priority security interests in and liens on all equity interests in most of the Trust's wholly-owned subsidiaries. Borrowings under the Credit Agreement will bear interest annually at a rate equal to, at our option, at either LIBOR (for one, three, or six months) or the Base Rate, plus in either case, a specified margin depending on our ratio of debt to total capital, as determined by the formula set forth in the Credit Agreement. The applicable margin ranges from 1.10% to 1.35% for LIBOR loans and 0.10% to 0.35% for Base Rate loans. The initial applicable margin was 1.25% for LIBOR loans and 0.25% for Base Rate loans. The Credit Agreement defines "Base Rate" as the greatest of (a) the Administrative Agent's prime rate, (b) the federal funds effective rate plus 1/2 of 1% and (c) one month LIBOR plus 1%. The Trust will also pay a quarterly revolving facility fee ranging from 0.15% to 0.35% (depending on the Trust's ratio of debt to asset value) on the revolving committed amount of the Credit Agreement. The Credit Agreement also provides for options to extend the maturity date and borrowing availability for two additional six-month periods. The margins over LIBOR, Base Rate and the facility fee are based upon our total leverage ratio. AtSeptember 30, 2022 , the applicable margin over the LIBOR rate was 1.20%, the margin over the Base Rate was 0.20% and the facility fee was 0.20%. AtSeptember 30, 2022 , we had$290.1 million of outstanding borrowings and$3.1 million of letters of credit outstanding under our Credit Agreement. We had$81.8 million of available borrowing capacity, net of the outstanding borrowings and letters of credit outstanding as ofSeptember 30, 2022 . There are no compensating balance requirements. AtDecember 31, 2021 , we had$271.9 million of outstanding borrowings,$3.2 million of outstanding letters of credit and$99.9 million of available borrowing capacity. The Credit Agreement contains customary affirmative and negative covenants, including limitations on certain indebtedness, liens, acquisitions and other investments, fundamental changes, asset dispositions and dividends and other distributions. The Credit Agreement also contains restrictive covenants regarding the Trust's ratio of total debt to total assets, the fixed charge coverage ratio, the ratio of total secured debt to total asset value, the ratio of total unsecured debt to total unencumbered asset value, and minimum tangible net worth, as well as customary events of default, the occurrence of which may trigger an acceleration of amounts then outstanding under the Credit Agreement. We are in compliance with all of the covenants in the Credit Agreement atSeptember 30, 2022 and were in compliance with all of the covenants in the Credit Agreement atDecember 31, 2021 . We also believe that we would remain in compliance if, based on the assumption that the majority of the potential new borrowings will be used to fund investments, the full amount of our commitment was borrowed. The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands): September 30, December 31, Covenant 2022 2021 Tangible net worth > =$125,000 $ 223,691 $ 225,355 Total leverage < 60% 42.8 % 43.1 % Secured leverage < 30% 6.3 % 7.4 % Unencumbered leverage < 60% 41.6 % 41.9 % Fixed charge coverage > 1.50x 4.6x 4.8x 31
-------------------------------------------------------------------------------- As indicated on the following table, we have various mortgages, all of which are non-recourse to us, included on our condensed consolidated balance sheet as ofSeptember 30, 2022 (amounts in thousands): Outstanding Balance Interest Maturity Facility Name (in thousands) (a.) Rate DateBRB Medical Office Building fixed rate mortgage loan (b.) $ 5,104 4.27 % December, 2022Desert Valley Medical Center fixed rate mortgage loan (c.) 4,235 3.62 % January, 20232704 North Tenaya Way fixed rate mortgage loan 6,294 4.95 % November, 2023 Summerlin Hospital Medical Office Building III fixed rate mortgage loan 12,621 4.03 % April, 2024Tuscan Professional Building fixed rate mortgage loan 1,879 5.56 % June, 2025 Phoenix Children's East Valley Care Center fixed rate mortgage loan 8,269 3.95 % January, 2030Rosenberg Children's Medical Plaza fixed rate mortgage loan 12,090 4.42 % September, 2033 Total, excluding net debt premium and net financing fees 50,492 Less net financing fees (293 ) Plus net debt premium 52 Total mortgages notes payable, non-recourse to us, net $ 50,251
(a.) All mortgage loans require monthly principal payments through maturity and
either fully amortize or include a balloon principal payment upon
maturity.
(b.) This loan is scheduled to mature within the next twelve months. We intend
to repay this loan in full utilizing borrowings under our Credit
Agreement.
(c.) This loan is scheduled to mature within the next twelve months. We intend
to refinance this loan prior to the maturity date.
On
The mortgages are secured by the real property of the buildings as well as property leases and rents. The mortgages outstanding as ofSeptember 30, 2022 had a combined fair value of approximately$48.3 million . AtDecember 31, 2021 , we had various mortgages, all of which were non-recourse to us, included in our condensed consolidated balance sheet. The combined outstanding balance of these various mortgages atDecember 31, 2021 was$57.2 million and had a combined fair value of approximately$59.4 million .
Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow.
Off Balance Sheet Arrangements
As ofSeptember 30, 2022 , we are party to certain off balance sheet arrangements consisting of standby letters of credit and equity and debt financing commitments. Our outstanding letters of credit atSeptember 30, 2022 totaled$3.1 million related to Grayson Properties II. As ofDecember 31, 2021 we had off balance sheet arrangements consisting of standby letters of credit and equity and debt financing commitments. Our outstanding letters of credit atDecember 31, 2021 totaled$3.2 million related to Grayson Properties II.
Acquisition and Divestiture Activity
Please see Note 4 to the consolidated financial statements for completed transactions.
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